PG&E Corp (NYSE: PCG) is an energy holding company whose primary subsidiary is the regulated utility, Pacific Gas and Electric. PG&E operates in 47 of 58 Northern and Central Californian counties and provides electricity and gas to over 9 million customers. As a regulated utility, PG&E has very little competition and a strong customer base. In 2009, it had 5.1 million electricity distribution customers, and 4.3 million natural gas distribution customers. Its business is stable and relatively low-risk because the utility can rely on a consistent customer base who pay rates determined by the state utilities commission.
Ultimately, PG&E’s future is inextricably tied to its relationship with the California Public Utilities Commission (CPUC). The CPUC is responsible for setting most of the regulations that govern PG&E’s business—most importantly the rates it is able to charge customers. In 2000, the CPUC set rates so low PG&E couldn’t turn a profit, which forced them into bankruptcy and contributed to the state-wide energy crisis. Since then, PG&E and the CPUC have had a better relationship, due in part to residual fears of another crisis. However, PG&E has to renegotiate its “rate-case” in 2011, so it is unclear how long the current trend will last.
Pacific Gas and Electric (PG&E) was founded in San Francisco in 1905 after the consolidation of more than two dozen power and water companies across California. PG&E began delivering natural gas to northern California in 1930 and after WWII began quickly building new power plants. In the late 1990s, deregulation of the California energy market allowed PG&E to sell most of its natural gas plants. While it continued to operate other types of plants (hydroelectric, nuclear, and a few remaining natural gas), this move forced the utility to buy power from outside energy generators at variable prices while providing energy to consumers at fixed rates. In 2000, energy costs became so high that California was pushed into an energy crisis that including rolling blackouts throughout the state. PG&E was forced to declare bankruptcy in April 2001 when it could no longer sell energy for more than it could buy on the open market. PG&E emerged from bankruptcy in April 2004.
PG&E provides gas and electricity to customers across Northern and Central California. The utility owns power-generation facilities that supply approximately 40% of its annual needs and purchases the rest. These facilities include 118 hydroelectric, nuclear, and fossil-fuel plants in California. During 2009, PG&E had revenues of $13.4 billion, and was able to post a net income of $1.23 billion in 2009.
PG&E supplies electricity to 5.1 million customers and gas to 4.3 million customers. As the dominant utility in the region, PG&E provides electricity to both homes and businesses. The corporate-sales side is particularly complex in Silicon Valley, where IT firms need especially high amounts of energy. PG&E also works with large customers (like Yahoo! (YHOO) and Adobe Systems (ADBE)) to help them design facilities that are energy efficient and keep power use low across their companies. Here is a breakdown of customer profiles for both the gas and electricity businesses:
Since the end of the California energy crisis, PG&E has benefited from a favorable regulatory environment. This is important since their business—especially their profitability—is fundamentally dependent on regulatory decisions. Most importantly, the California Public Utilities Commission (CPUC) sets the prices at which PG&E can sell its energy. This contributed to the 2000-2001 energy crisis when the rates were set too low for PG&E to turn a profit. Since then, the utilities have been much more pro-utility and PG&E has enjoyed a strong relationship with CPUC.
At the beginning of 2007, PG&E reached a deal with the California Public Utilities Commission regarding customer rates. This deal allows PG&E to pass on infrastructure costs to consumers in order to generate strong returns and continue investing in new technology and other capital projects. The agreement sets a minimum return on equity for PG&E’s core businesses (electricity distribution and generation and gas generation) at 11.22%. This agreement will stay in place until the Utility’s debt is rated A- by Standard & Poor’s or A3 by Moody's (MCO).
Although the regulatory environment is strong now, future changes could have significant effects on PG&E. The CPUC conducts annual cost of capital assessments to determine the authorized capital structure and allowed returns on equity. This affects the rates PG&E can charge its customers and the speed with which the Utility can invest in its infrastructure. Furthermore, PG&E’s entire rate-case (the rates they can charge customers) will have to be renegotiated in 2011; possibly affecting the company’s ability to turn a profit. Finally, as mentioned above, if PG&E’s debt reaches the minimum threshold, it will potentially be subject to further regulatory shifts. 8)
One additional factor to take notice of in PG&E's regulatory environment is the implementation of AB 32, California's landmark climate change law. The law left the CPUC, the California Energy Commission (CEC), and the Air Resources Board (ARB) substantial discretion in implementing the law, which requires California's greenhouse gas emissions in 2020 to be returned to the emissions level of 1990.
The electricity sector is the most likely to initially be included under any cap and trade system (the law does not specifically require a cap and trade program, but such a program has featured heavily in initial analytical recommendations). On June 22, the CEC held one of the first public meetings on the controversial issue of how carbon permits, or "allowances", would be distributed in the case of a cap and trade. (Allowances can be publicly auctioned, "grandfathered" on the basis of historical emissions, distributed according to some other criteria, or any combination of these methods.) PG&E stands to gain substantially if the allowances are not allocated on the basis of historical emissions, but are distributed according to carbon-neutral criteria, like electricity sales or demographics. This is because PG&E's carbon intensity (the tons of carbon emitted per megawatt hour of electricity sold) is the lowest of the three major private California utilities (and almost as low as some of the least carbon-intensive public utilities, like the Sacramento Municipal Utilities District). Of course, whether these gains could be passed on to shareholders ultimately depends on the actions taken by the CPUC if it appears that PG&E will be able to sell a large excess of carbon allowances.
California’s increased focus on environmentally-friendly policies has put PG&E in a prime position to benefit from impending legislation. By 2010, energy companies in California will be required to limit the amount of coal-produced power they rely on to 3% and increase their usage of renewable energy to a minimum of 20%.
PG&E has made a commitment to providing clean energy options to its customers and is a leader in renewable energy innovation. Over 13,000 PG&E customers now use solar energy technology. PG&E is also exploring new technologies that leverage renewable energy including wave power off the California, large-scale solar power stations, and renewable natural gas supplies from California cows.
Among utility companies, PG&E has already emerged as a leader in the renewable energy movement. It already emphasizes renewable energy sources and has made a commitment to innovative clean energy, so it is well-positioned to take advantage of the trend towards renewable energy. If the regulatory environment changes too quickly, however, and mandates excessively high amounts of renewable energy, that could trigger a supply shortage which could lead to more widespread problems throughout the industry that would also affect PG&E.
As a monopolist, PG&E does not have to worry about competition, but does have to take into account population growth rates and migration patterns. This means that for PG&E to grow, it has take advantage of changes in the populations of the regions it serves. Fortunately for PG&E, the population in Northern California is relatively stable, and the population in Central California is among the fastest growing in the nation. PG&E is working to ensure that its infrastructure is able to meet increasing demand in central parts of the state.
PG&E is also subject to fluctuating energy prices. PG&E currently generates only 40% of the energy it sells annually and must buy the rest of the energy on the open market. Since regulations created at the end of the 2000-2001 energy crisis, and the discovery of Enron-led manipulations of the energy market, energy prices have remained stable and have allowed PG&E to make a profit. At present, PG&E is currently in the process of buying new power generating facilities and exploring other ways to wean itself off of externally-bought power. Despite these efforts, PG&E will always have to purchase a significant amount energy at market prices, which potentially leaves the utility open to price shocks in the future.
As a regulated utility company, PG&E has no real competition in the markets it serves. In other parts of California, two other energy concerns provide power: Southern California Edison and San Diego Gas & Electric. Nationwide, PG&E performs well compared to other utilities and is even considered a “bellwether” company in the domestic utility industry because of its especially constructive relationship with the CPUC and the growing California electricity market—since 2003, PG&E has grown twice as fast as the industry as a whole. While not the only company to provide both gas and electricity, PG&E is in the minority as more utilities focus exclusively on electricity.